U.S. bank regulator airs caution on leveraged loan market

WASHINGTON (Reuters) - A U.S. bank regulator believes that banks should be increasingly aware of activity in the leveraged lending market, cautioning rapid growth in that sector by nonbanks could pose future risks to the financial sector.

FILE PHOTO: Joseph M. Otting speaks after being sworn in as Comptroller of the Currency in Washington, U.S., November 27, 2017. REUTERS/Joshua Roberts/File Photo

The U.S. Office of the Comptroller of the Currency (OCC) highlighted loans to highly-indebted companies in its semiannual risk report issued on Monday.

While lending by banks in that sector does not seem exceedingly risky, the OCC cautioned near-record issuance in that sector, driven by nonbanks like private equity firms and hedge funds, merits closer attention.

“The banks, generally, we feel comfortable with their underwriting and how they’re performing within the leveraged lending market. But it is clearly something for us all to keep an eye on,” U.S. Comptroller Joseph Otting said on a call with reporters.

Leveraged lending has attracted some attention in Washington of late. Democratic Senator Elizabeth Warren pressed regulators earlier this month about underwriting standards in that market.

The Federal Reserve is also hearing more from concerned parties about the leveraged loan market and how it could complicate future economic downturns.

Randal Quarles, the Fed’s vice chair for supervision, earlier on Monday said the U.S. central bank is studying banks’ exposure to leveraged debt.

Speaking in New York, he noted that banks do not hold most leveraged loans or collateralized loan obligations on their books, but the matter and potential risks they present are being analyzed.

The average leverage for large corporate loans is at a record high, the OCC noted in its report, adding that banks can sometimes be indirectly exposed to riskier lending in the space through investments in debt funds or private equity funds.

Overall, the OCC found credit quality on bank loans to be generally strong, but noted that credit risk is building. Growing competition for new loans, particularly from nonbanks, is pushing banks to consider riskier lending, the regulator warned.

The OCC also identified cybersecurity as a key operational risk for banks. Otting called it a “critical risk” that if not properly managed could pose a fundamental threat to financial institutions.

The regulator noted that banks rely on third-party providers for a range of services, which can pose their own risks if not properly monitored.

“Cybercrime and espionage increasingly target third-party service providers to gain access to bank information or systems,” the OCC warned.